Paving the Way for Covered Bonds

HousingWire snagged a few minutes with Rep. Scott Garret, R-N.J., to talk about the covered bonds legislation sponsored by the congressman. Here’s how that conversation took place on a busy Wednesday of the week before Christmas in 2009:
HW: You were on the floor moments before our conversation today. Can you tell us about what’s happening there on the Hill?
Garrett: Yes, I was on the floor before. Today, the majority is trying to wrap up as much of their legislation as they can before we leave town for the holidays. The major bills are the debt increases. The ceiling on the debt will be going up by $290 billion. The C.R. or continuing resolution is basically continuing funding for the Department of Defense and others. That just passed. The stimulus bill is also on the floor as well.
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HW: Do you believe the covered bonds act is as important as some of these other major bills going through?
Garrett: Yes. These are all bills the majority feels they need to do before the end of the year. Covered bonds. in my opinion, should have been done a while ago so we’d have it as a vehicle to navigate our way out of this economic morass that we’re in now. But we didn’t, despite calls from me and others to move this. As you’re probably aware, we had a hearing on it earlier this week.
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Garrett: To those who like securitization, I would respond: so do I. I have no problem with it. But as they well know, right now it’s pretty well frozen up. Had we passed this bill a year ago, let’s say, so the mechanisms could just about now—considering the way the government operates—be all in place so covered bonds could be rolling off the ground, then this market would begin to be opening up. Whereas with securitization, here we are a year later after the meltdown, we’re still pretty well seized up. That’s why what would be wrong to allow this as an option to be out there. It’s not like what the majority is trying to do, which is to mandate that you do something. This bill doesn’t say this is the only avenue for finance and this is the one you have to use. We’re just saying let’s make it a piece of the puzzle. And right now I think it would be a piece that some of the markets would be open to.
HW: We also spoke with Alberto Basu, who is the guy who does the other covered bond at JPMorgan. He’s based in London, and he said the important thing is that this act you’re sponsoring sort of implies to the investor community that the government is sponsoring or sort of stamping a seal of approval. He felt those words in particular are a bit stronger than the actual relationship the government would have to a covered bond market. But the passage of a covered bond act would do more to increase investor inquiries into this product than anything else that’s achievable. Do you think he has a valid point?
Garrett: Yeah. This was addressed not exactly on point during the hearing this week when it was asked by members of Congress why covered bonds have not taken off yet in the United States. It’s not prohibited. There have been a couple of issuances. The former Treasury secretary [Henry Paulson] last year came out and said it was a good idea. Why didn’t it take off when he did that? Why didn’t it take off when some of the basic guidelines were being suggested? The answer is because, without a statutory framework in place, the market is not going to be confident going forward in the United States since we have no history of it. The vast market is going to look for that statutory framework—something formal in place that they can rely on for any points of contention or uncertainties.
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HW: We all know covered bonds have yet to default; they’re the safest structured product out there. The bank is of course on the hook, but there’s no insurance for the bank if the bank defaults. While you can swap out good and bad collateral on the bank, if the bank defaults—which we’ve seen nearly every Friday in 2009—how do you envision the FDIC playing a role? Would it cover them like the same retail deposits are covered?
Garrett: That is one of the issues out there. It’s the FDIC that has questions on going forward with this. They would like to know how they’re going to meet their ultimate obligation, which is to protect the depositors. Another issue is, if there’s a segregation of the good assets into the pool, how does that affect the FDIC? It was also brought up at the hearing that Bert Ely and [House Financial Services Committee] Chairman Barney Frank raised a good question when he asked do we look someplace else such as Federal Reserve to provide the liquidity necessary to the bank while there’s the period of time for the bank to work its way through it if the assets in the covered pool are not adequate, or is there some other mechanism? That’s one point that I think we’ll want to have some more discussions on.
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Jacob Gaffney is the Editor-in-Chief of HousingWire and HousingWire.com. He previously covered securitization for Reuters and Source Media in London before returning to the United States in 2009. While in Europe for nearly a decade, he covered bank loans and the high yield market, in addition to commercial paper, student loan, auto and credit card space(s). At HousingWire, he began focusing his journalism on all aspects of the housing and mortgage markets.

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